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Tuesday, August 11, 2009

Mortgage Laws and the Case for Moving Insurance Across State Lines

The most common argument against allowing health insurance to move across state lines is that each state has their own state laws governing health insurance and thus it is not practical to do this. Different states have different levels of regulations and allowing health insurance to cross state lines would turn into chaos and take power away from the states the critics say. The critics say that insurance companies will simply set up shop in those states with the loosest regulations.

Today, I asked Sandy Praeger to share her perspective on the issue. Praeger is insurance commissioner for Kansas and president of the National Association of Insurance Commissioners.

Praeger told me she was against lifting restrictions on the sale of insurance across state lines.If the change was implemented, here’s what she predicts will happen: Insurers will set up shop in states with few regulations and market low-cost policies to people across the country. These policies will offer minimal coverage and appeal primarily to younger consumers.

“It will be a race to the bottom,” Praeger said, and there will be “very few consumer protections. … You’ll have plans that don’t cover the benefits that people need. … And healthy people are going to buy those less costly plans, because they don’t think they need [the protection].”

Now, I have dealt with something similar in mortgages for years. In fact, in mortgages, there are numerous state laws and federal laws. For instance, in Illinois, there is something called the Illinois high cost law. This law does two things. First, it sets a maximum rate that any borrower can be charged on any loan. Second, it sets the maximum fees that can be charged on any loan, 5.5%. My only experience with Illinois high cost was when a protege of mine tried to do a difficult loan that was deemed illegal at the end of the process. This was a loan on an investment property with a borrower with a marginal credit score and they were putting little down to purchase the property. As such, the rate on the loan approached 11%. Everything seemed fine until we got the loan ready to close and the bank realized it couldn't be done because the rate was illegal. In fact, there was no way to make the loan legal.

Illinois high cost also comes up often for FHA loans. That's because there is a 1.5% fee that FHA charges up front for Mortgage Insurance Premiums. As such, before anyone charges a single dime, there is already 1.5% of the 5.5% used. Of course, different banks have different interpretations of whether or not that 1.5% should be counted in the overall 5.5%. So, often there are disputes between bank and broker about whether or not a loan has exceeded the Illinois High Cost law.

That's just in the state of Illinois. The state of Minnesota has created all sorts of state laws to prohibit "predatory lending". The state of North Carolina also has very strict "predatory lending" laws. If a bank wants to do business in any state, they must follow the laws of that state along with federal laws as well rules set out by Fannie/Freddie and FHA. Sometimes, laws become so burdensome that banks actually stop doing business in a state. For instance, HB 4050, in my county of Cook, became so burdensome in 2006 that dozens of banks simply stopped doing business in that County.

Why do I point this out? It's because mortgages is among the most heavily regulated industries in the country. Anyone who has ever closed on a loan knows full well just how regulated it is since they sign hundreds of pages worth of closing documents in response to regulation. We have something called a regulation z. That's because there are so many regulations that they span the alphabet. Each individual state sets out their own regulations along with federal regulations. Yet, banks are able to sell loans across state lines even despite this hyper regulation.

In other words, the mortgage industry allows for mortgages to "cross state lines" despite the plethora of competing regulations. In fact, banks, much like insurance companies, set up shop in one state and then sell mortgages across state lines. They are able to figure out how to navigate all of the state laws, federal laws, and other regulations, and still be able to produce their product in all fifty states at one time. The regulations and complexity of mortgages is no less than is the regulations and complexity of health insurance. Yet, banks are able to figure out how to sell mortgages across state lines, and no one is claiming that you can only get a mortgage from a bank in your home state. In the same way, we could figure out how to sell health insurance across state lines.